Plug into the Utility Sector and High Yield Dividend Stocks

With all the market volatility of the base few weeks, investors can be forgiven for seeking safety in investments like high yield dividend stocks. Assets like Treasury bonds and gold have done well. From its April highs, the S&P 500 is down more than 12%. In comparison, the Gold Trust ETF (GLD) is up +11%. And the Direxion 30 Year Treasury Bull 3x (TMF), which returns three times the daily return of 30 Year Treasury Bonds, has gained +47%.

With stocks now looking ready to stabilize and with evidence that institutional investors are buying stocks at the fastest rate since December based on client data from UBS, it’s time to move back into equities. But if you’re like most investors, you’re feeling a bit shell shocked and gun shy.

No worries. There are opportunities to be had in defensive utility stocks that offer attractive dividend yields at current levels. Here are a few examples of large, stable utilities offering dividends well in excess of the 3% you get on 10-year Treasury bonds: Pepco Holdings (POM) with a 6.8% yield, First Energy (FE) with a 6.1% yield, and Duke Energy (DUK) with a 6% yield. There was actually a Duke Energy dividend increase just this week.

Utilities analyst Daniel Ford at Barclays Capital published a lengthy research note this week in which he upgraded the entire sector to a buy equivalent rating as a number of factors are poised to “lead relative outperformance over the next 12-18 months.”

The first is that utilities tend to be late-cyclical/early-defensive plays with high dividends. Historically, according to Ford, the utilities sector as a whole has outperformed the broad market by 8.4% in the period from 15 months to 24 months after a recessionary trough. He believes we’re at such an inflection point now.

Utilities are also attractive on a relative valuation basis. Utilities on average are yielding 4.8% with expectations for dividend growth of 3.9% over the next five years. Based on historical yields, this puts the group 11% cheap to corporate bonds and 35% cheap to 10-Year Treasuries.

And finally, both the regulatory picture looks better going forward, capital spending plans are set to slow (easing pressure on balance sheets), and demand growth is expected return as the economy returns to full capacity and factories spool up again. If you want to play the sector as a whole, check out the Utilities SPDR (XLU) which offers a 4.4% yield.

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